How Much Are Your Investments Costing You? Part 2
Specific Examples
In Part I of this series we reviewed the basics of how investment fees work and introduced the tool we will be using in Part II. If you haven’t read Part I yet, this probably won’t be terribly helpful.
Example 1: Employer based 401k savings plan
For many people this is the first investment account they open. During new employee orientation you fill out a form to contribute to the company 401k retirement plan. At some point you pick where that money will be invested, which is typically a fairly small menu of mutual funds. As long as you stay at the same company, this account stays with you. If you leave for another job the account won’t move with you unless you take steps to move (roll it over) to another plan. So, if you have one of these accounts still hanging around, this example is for you.
Typical range of fees: 0.4% to 1.0%
Employer based plans like this typically have a few low cost options like Target Date funds or S&P 500 index funds. Other funds may have considerably higher fees. In the diagrams below we will compare the difference in real dollars between the high and low ends of the range.
As you can see in this example, paying 1.00% instead of 0.40% in expenses ends up costing ~$19,000 more over 20 years. The larger the account size, the more you will pay in fees as seen below.
As can be seen above, even a modest 0.4% yearly fee will end up costing you nearly 30% of the original money you invested after 20 years. Paying 1% fees pushes that up to almost 70% of your original investment. While this probably is eye opening, the following two examples are even more extreme.
Example 2: Investment account not connected to an employer.
This could be an IRA, Roth IRA, regular brokerage account or even a 401K from a previous employer that you rolled over into an account not connected to a new employer.
These accounts have the most options available and the resulting fees will depend on who makes decisions about how the money is invested. The lowest cost option is available to those who make the decisions themselves. Turning your money over to someone else to manage of course comes with the highest costs. There are many options between the two extremes however so finding the right mix of control and cost is a personal decision.
Self managed account estimate: 0.15% Total Fee.
This can be easily achieved using a variety of index mutual funds or etfs. You can even choose a Target Date mutual fund which automatically adjusts as you get closer to retirement age. If you instead choose actively managed mutual funds the fees will range from around 0.4% to 1.0%.
Advisor managed account estimate: 1.5% Total Fee
If you turn over the decision making to an outside company or individual you will pay on average a 1% management fee on the total money you have invested. On top of that you will also pay fees on the products they choose to purchase with your money. These will typically be actively managed mutual funds and come with additional expenses in the range of 0.4% to 1.0% giving an estimated total expense of around 1.5%
The charts below will give you an idea of what you could expect to pay when managing your own money vs. having someone else manage it for you. These are my estimated average figures, not the absolute cheapest or most expensive for either option.
These figures really speak for themselves but one thing really stands out to me. Can you imagine taking your $50,000 to an investment advisor and being told the following: “We will invest your money for 20 years and at the end the total cost to you will be almost as much as what you are starting with: $47,596.” Would you invest your money under those conditions? I have a feeling most of us would start looking for other alternatives.
As extreme as this example is, there is another option which is even more expensive: Variable Annuities.
Example 3: Variable Annuities
Variable Annuities are complex financial products that combine features of insurance and stock market investments. They can be useful in certain situations but it is important to understand they also come at a very high cost. As in our other examples the costs are normally expressed in terms of percentages instead of dollar figures we can understand.
Variable Annuity average fees: 2.5%
Determining the fees involved can be quite complicated and involves examining the annuity contract in detail. There is typically a base charge for the annuity, then additional optional features which add cost. On top of this are the fees for products the annuities invest in which are often actively managed mutual funds. Total costs can vary widely but 2.5% seems like a pretty good middle ground.
For more details on different types of annuities and the related expenses involved refer to the information here.
Make sure you are sitting down before looking at these next charts showing the impact of variable annuity fees:
Unfortunately with variable annuities, there is no low cost option. Only you can decide if the possible benefits an annuity can provide are worth the enormous cost. I would not rely on an annuity salesperson to help you make this decision.
Another even larger issue with annuities is how they are taxed when they are inherited. This topic is too complex to get into in this post but through my own experience I have learned that the tax impact of inheriting an annuity makes the yearly fees above look insignificant in comparison. If you or a family member are questioning the value an annuity provides versus its cost then it would certainly pay to also look at the tax implications. Careful planning would be needed but you can move money from an annuity into a normal brokerage account and save on fees as well as taxes.
In summary, I hope this information helps you become more aware of the costs involved with your particular investment choices. You may decide the expenses are worth it in your situation or you might decide to make a change. Please let me know in the comments if this helped you or you have any questions.
